By Dana Mattioli, Anupreeta Das and David Benoit
The Dow Jones Industrial Average's recent rise has lifted many
stocks in Berkshire Hathaway Inc.'s portfolio. But Berkshire chief
executive Warren Buffett is probably less thrilled with the rally
in another Dow.
Shares of Dow Chemical Co. have spent much of the past month
hovering above $53 -- perilously close to a level that would cause
Berkshire to lose a $255 million-a-year income stream.
Since 2009, when Berkshire lent Dow Chemical $3 billion to help
finance its purchase of Rohm & Haas, Dow has been on the hook
for paying an 8.5% annual dividend on three million shares of
preferred stock. Those shares have resulted in more than $1.5
billion for Berkshire. As Mr. Buffett likes to say, that amounts to
$8 a second.
But the agreement has an escape hatch. If Dow's shares exceed
$53.72 for at least 20 trading days in a 30-day period, the
chemical company can convert Berkshire's preferred shares into
common stock, which doesn't pay out special dividends. Kuwait's
sovereign-wealth fund also lent Dow $1 billion under the same
terms.
Dow executives haven't made a secret of their desire to execute
that conversion and to shut off the dividend spigot -- and Mr.
Buffett, conversely, wants to avoid the evaporation of those
dividends.
That has fueled speculation among some bankers and investors
that Mr. Buffett or Berkshire are shorting Dow's shares as a way to
exert downward pressure on the stock and avoid triggering the
conversion.
Mr. Buffett declined to comment on whether he or his company
have been shorting the shares.
"We have no knowledge or facts to support the position that it
is directly Berkshire Hathaway" shorting Dow's shares, said Dow
spokeswoman Rebecca Bentley.
The 2009 preferred-stock agreement had barred Berkshire from
shorting Dow shares until April 2014.
Since then, Dow's stock has repeatedly flirted with that magic
$53.72 level, and occasionally breached it, only to quickly
retreat. Propelled in part by Dow's pending deal to merge with
DuPont Co., the shares peaked last year above $57 before rapidly
declining to the low $50s. The shares were trading at $53.72 midday
Wednesday in New York.
Although short interest in Dow, or the amount of shares of Dow
stock that are sold short, is down for the year and dropped to $600
million at the end of July, short sellers have increased their
positions by almost $100 million in August, up 16%, said Ihor
Dusaniwsky, head of research at S3 Partners, a financial analytics
firm.
Its failure to breach the mark is despite improved earnings and
margins, cost cuts, the shedding of assets, an activist shareholder
who shook up the board, and a combination with its biggest
rival.
Dow Chemical is trading at steep discounts to its largest rivals
based on price-to-earnings metrics, at 7.87 times its earnings
versus a median 27.52, according to FactSet. Wall Street analysts
have also turned more bullish on the stock. Heading into 2013, more
than half of analysts called the stock a "hold" and had a median
price target of $42.79, FactSet shows. Today, 65% of analysts rate
the stock a "buy" and the median price target is $59.63, well above
the threshold.
The stock's refusal to go higher is proving frustrating to the
company, people familiar with the matter say.
Dow executives have occasionally floated the idea to Berkshire
executives of finding a way to terminate the deal, although there
has never been a formal proposal, according to people familiar with
the matter. Ms. Bentley said Dow continuously reviews its capital
structure, "with the best interests of all of our shareholders as
our sole criteria for any actions we take."
The agreement, and others like it, date back to the financial
crisis. When credit markets seized up in 2008, some blue-chip
companies turned to Mr. Buffett and Berkshire's store of cash for
help in shoring up their balance sheets or completing acquisitions.
Of course, these companies were getting more than just the cash --
they were also winning public votes of confidence from the
billionaire investor.
From 2008 to 2011, Berkshire shelled out roughly $25 billion for
preferred securities of Dow Chemical, Bank of America Corp.,
General Electric Co., Goldman Sachs Group Inc., Swiss Re and Wm.
Wrigley Jr. Co.
Preferred-stock deals typically come with conditions under which
the issuing company can redeem those shares, such as a threshold
price or an additional payout. For instance, GE, which got a $3
billion infusion from Berkshire in 2008, agreed to pay Berkshire
$300 million in annual dividends and another $300 million whenever
it redeemed the preferred stock. In 2011, the industrial
conglomerate paid $3.3 billion to Berkshire to buy back those
shares.
The billionaire investor often laments the loss of these income
streams when companies choose to redeem their preferred shares from
Berkshire. He has described the redemptions by Goldman and GE as an
"unwelcome" development. Mr. Buffett likes these deals because they
are a relatively easy way for Berkshire to make money, simply by
using a portion of the cash on its balance sheet at a high
interest.
Companies have paid up for the privilege of having Mr. Buffett's
name attached to their deals even without crisis conditions. In his
most-recent annual letter, the billionaire wrote that Kraft Heinz
Co., of which Berkshire owns 27%, would redeem $7.7 billion of
preferred stock in June, which was "bad news for Berkshire."
Although Kraft did redeem the stock for $8.3 billion, paying
Berkshire $620 million in the process, the conglomerate loses
dividends totaling $720 million a year from now on.
Bank of America and Dow are among the few companies that haven't
redeemed their preferred shares from Berkshire's crisis-era
investments. Berkshire invested $5 billion in the bank in 2011,
which pays about $300 million in annual dividends. Berkshire also
has until 2021 to exercise warrants for 700 million common shares
for an additional $5 billion at $7.14 a share. Based on the bank's
current stock price of about $15, the warrants create a paper
profit of around $5.5 billion.
Write to Dana Mattioli at dana.mattioli@wsj.com, Anupreeta Das
at anupreeta.das@wsj.com and David Benoit at
david.benoit@wsj.com
(END) Dow Jones Newswires
August 24, 2016 14:34 ET (18:34 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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